extensive Investment
FRAUD RISK EXAMINATIONS
Ponzi Schemes
Although fraudsters can utilize numerous actual or fabricated derivations of investment products to perpetrate their crimes, the Ponzi scheme is the vehicle of choice by which most operate. The Ponzi scheme, the most prevalent type of investment fraud, is where investors believe a company’s success originates from profitable business operations, e.g., trading, real estate, and product sales. However, they remain unaware that other investors are the source of those profits. The Ponzi scheme generates returns for older investors by acquiring new investors and using these new funds to repay earlier investors.
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Investing in alternative assets such as hedge funds and Regulation D private placement offerings requires much more than understanding an investment strategy. It is critical to assess the soundness of the business model and evaluate the scope and effectiveness of firm oversight and controls. Equally important is examining the financial instruments and corresponding asset classes being examined.
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Although Ponzi schemes can reside anywhere, they tend to incubate and thrive within the alternative asset environment. Hedge funds and Regulation D (Reg D) private placements are complex vehicles that may invest in various alternative assets, including private equity, futures, options forex, real estate, commodities, precious metals, structured derivative products, consumer or commercial products, and even collectibles. Applying subject matter expertise to these complex financial instruments with unique payoff diagrams is a prerequisite to any investigation.
We employ several methods to identify and measure investment fraud risk that includes:
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securing legal documents, financial statements, and regulatory filings
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performing extensive background checks
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testing the quantitative validity of performance returns
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verifying the existence of client assets
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mapping the investment firm ownership structure
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evaluating sales and marketing material and client-offering documents
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assessing trading procedures, internal control policies, and asset valuation and fund accounting methods
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surveying outsourced service provider relationships and possible conflicts of interest
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documenting ongoing operational risk concerns and potential for fraud.
The deliverable, an Investment Red Flag Report (RFR) presented in a one-on-one consultation, communicates a professional opinion founded on targeted information. Our RFR illustrates a 360-degree perspective of the investment, investment firm, principals, key employees, and service providers. This information promotes greater transparency and enables better decision-making, giving you an advantage: the ability to act quickly, possibly reducing the chances of falling victim to investment fraud and avoiding significant losses to your finances, reputation, and legacy.
Securities and investment fraud involve products such as stocks, bonds, mutual funds, pre-IPO issues, penny stocks and micro caps, promissory and prime bank notes, high-yield bonds, futures, options, forex, precious metals, fixed and variable annuities, multi-family real estate, REITs, collectibles, structured products, Reg D private placements, managed futures accounts and funds, and hedge funds.
Securities Fraud
Investment fraud Ponzi schemes can be perpetrated by unlicensed individuals or those licensed in the financial industry. We investigate securities and commodities fraud committed by FINRA and NFA-licensed individuals holding Series 3, 6, 7, 31, and 82 licenses and Series 65 Registered Investment Advisors (RIAs) for instances of misconduct and civil or criminal fraud. Securities and commodities fraud transpires when a licensed party (broker, financial advisor, Registered Investment Advisor) misrepresents or makes false statements during any stage of the investment process. Most instances of fraud occur during the sales process when brokers may withhold material information, divert a conversation, or outright lie – using any means to downplay risk, boost profit potential, and avoid investment suitability and liquidity questions.
Other securities fraud violations involve the conduct of fiduciaries. Trustees, for example, must provide investment advice that always acts in their client's best interests. A breach of this duty can make the trustee liable for losses from mismanaged securities. The Cornell Law Dictionary defines fiduciary duty as “performing the highest standard of care." It means always acting in your client’s best interest first. Fiduciaries sometimes breach their duty by recommending financial products based on commissions or as part of a soft-dollar arrangement, which may not be the best option for the client.
Examples of common regulatory violations include but are not limited to:
Breach of Fiduciary Duty
A fiduciary is someone who has been placed in a position of trust and confidence and has a duty to act in his or her clients’ best interests. Registered Investment Advisors (RIAs), trustees, attorneys, and CPAs who maintain discretionary authority over investment accounts are fiduciaries. Breaches of fiduciary duty include unsuitable investments, excessive trading, and misrepresenting investment risk.
Churning or Excessive Trading
Churning occurs when an investment advisor or broker trades excessively in a client’s account to generate commissions.
Failure to Supervise
Brokerage firms must maintain and enforce internal policies to adequately supervise investment advisors and brokers licensed through that firm. Therefore, if an investment advisor or broker engages in misconduct, causing a client to incur financial losses, the supervising firm may be liable for allowing said misconduct to occur.
Investment Misrepresentation and Omission
Financial advisers and brokers must disclose all the risks associated with the investments they recommend to their clients. They may misrepresent or omit material facts such as risk, fees, expenses, and liquidity to sell a particular investment.
Negligence
An investment advisor or broker's negligence is any conduct that falls below the standard of care that a reasonable, prudent person would have utilized in the same situation. Suppose a reasonable, prudent financial advisor would have foreseen the potential consequences of such an act and not taken reasonable steps to prevent such consequences. In that case, the act can be deemed negligent.
Over Concentration
When an investment advisor or broker recommends investing all or a large percentage of assets in one product or industry sector, there is more potential for excessive losses than in a more diversified portfolio.
Selling Away
Selling away is when an investment advisor or broker sells or solicits the sale of securities or financial products not held or offered by the brokerage firm with which he or she is registered or affiliated.
Unsuitable Investments
An investment advisor or broker must know and understand clients and recommend suitable investment strategies. Investment recommendations must be consistent with the client’s expectation of returns, tolerance, appetite for risk, and overall investment experience history. For example, an investment may be deemed unsuitable if a client cannot incur the potential loss associated with an investment's inherent risk or if the client was not adequately educated about the risks associated with the recommended investment.
Unauthorized Trading
Unauthorized trading occurs when an investment advisor, broker, or third party who does not have discretionary trading authority over an account places trades without obtaining the client’s prior approval.
Variable Annuity or Mutual Fund Switching
When an investment advisor or broker recommends selling out of one mutual fund or variable annuity and buying into another. Switching may be done to generate higher brokerage commissions and may not necessarily be in the client's best interest.